Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Michael L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
The Income Statement and the
Retained Earnings Statement
Chapter 3
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Introduction
 The income statement is the primary source of
information for a company’s current profit
performance

Financial statement readers use this and other
information to:
 estimate the amount, timing, and uncertainty
of the firm’s future income and cash flow
 evaluate performance
 provide feedback
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Nature of Income
 Change in Retained Earnings
 Economic Income versus
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Accounting Income
Inclusiveness of the
Income Statement
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Change in Retained Earnings
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Economic Income vs. Accounting Income
 Economic Income: an increase in the wealth of a
corporation; a measure of income based on events
rather than transactions
 Events approach:
a method of assessing financial
performance and position based on economic events
rather than completed transactions
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Economic Income vs. Accounting Income (cont.)
 Accounting income:
an increase in the reported
wealth of a corporation based on actual transactions
completed; a measure of income based on the
accounting model
 Transactions approach:
a method of assessing
financial performance and position based on
completed transactions rather than events
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Inclusiveness of the Income Statement
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Which items affecting shareholders’ equity should be
included in the computation of net income & reported
in the income statement?
Two extreme approaches offered:
 Current operating performance: includes only
items that are part of the ordinary recurring
operations of the firm; gains and losses in prior
periods, or unusual or non-recurring activities are
recorded as direct adjustments to retained
earnings.
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Inclusiveness of the Income Statement (cont.)
 All-inclusive approach: includes all
transactions affecting the net increase or decrease
in equity during the period, except contributions by,
or distributions to, the owners
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Inclusiveness of the Income Statement (cont.)
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Current practice in Canada reflects an approach
closer to the all-inclusive approach
Virtually all items affecting equity (minus investment by
or distributions to owners) are included in net income
The AcSB has largely eliminated the possibility of
charging or crediting items directly to retained
earnings, except for corrections of errors and for
restatements due to changes in accounting policies
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General Presentation Format

Accounting standards require three specific subtotals
on its income statement, when applicable:
 income before extraordinary items & discontinued
operations: income from continuing operations
 income before discontinued operations: after
adding and subtracting extraordinary gains and
losses, if any
 net income: after adding and subtracting gains and
losses from discontinued operations
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General Presentation Format (cont.)

CICA Handbook requires a few specific items be
disclosed (CICA 1520.03)
 revenues recognized
 investment income
 amortization expense
 research and development expense
 interest expense
 income tax expense
 earnings per share
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Single Step Format
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Single-step format uses only two broad classifications
for presenting income from continuing operations:
 a section showing revenues and gains
 a section showing expenses and losses
Income from continuing operations is computed in one
step, without intermediate subtotals
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Multiple-Step Fully Classified

The various categories of revenue and expense that
appear on a fully classified income statement are:
 operating revenues
 cost of sales
 operating expenses
 operating income from continuing operations
 other income and expense
 income tax
 discontinued operations
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Other Format Choices
 Title
 Fiscal Year End
 Reporting Period’s
Length and Composition
 Reporting Currency
 Selection of GAAP
 Rounding
 Language
 Comparative Data
 Detail
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Income as a Predictive Tool
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Earnings trends are important analytical tools used by
investment analysts and investors in forecasting a
company's future earnings
Forecasts of future earnings are one factor often used
in making investment decisions
Past trends and performance do not guarantee
continuation of such trends and performance in the
future, but they are often useful predictors
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Special Aspects of the Income Statement
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Intraperiod income tax allocation
Restructuring charges
Discontinued operations
Extraordinary items
Unusual items
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Intraperiod Tax Allocation
 Item shown net of related tax:
the tax
consequences of the item have been determined and
the reported amount is shown after these tax effects
have been adjusted for
 Intraperiod tax allocation: intra means that the
allocation is within the period and within the income
statement and retained earnings statement
 Interperiod tax allocation:
the allocation of tax
expense to different reporting periods
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Restructuring Charges
 The Emerging Issues Committee prescribes that
the estimated costs and losses be charged to
operations in the year the restructuring decision
is made
 This policy is consistent with the policy applied
to discontinued operations
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Discontinued Operations

Discontinued operations are treated similar to
restructuring charges except that the gain/loss
associated with the discontinued operations are
segregated on the income statement
 a manufacturer eliminates a significant and
distinguishable product line
 a food distributor that normally sells its products
directly to restaurants sells its wholesale
division that sold products to its retail outlets
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Discontinued Operations (cont.)
 Specifically, two components of income
resulting from discontinued operations
must be disclosed separately:
 results of operations for the discontinued
segment before the disposal decision, net
of tax
 gain or loss (net of tax) from disposal of a
segment of a business, including the
income or loss from operating the
business during any phase out period
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Discontinued Operations (cont.)
 Full disclosure of a discontinued operation includes
the following:
 identification and description of the business
segment discontinued
 the measurement date and the actual or projected
disposal date
 the actual or expected manner of disposition
 a description of the assets, by major classification,
of the discontinued segment
 revenue attributable to the discontinued segment for
the reporting period
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Extraordinary Items

Section 3480, CICA Handbook–Transactions or events that
have all of the following characteristics:
 are not expected to occur frequently over several years
 do not typify the normal business activities of the entity
 do not depend primarily on decisions or determinations by
management or owners
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Extraordinary Items (cont.)
 Section 3480–Events that are not extraordinary items:
 losses and provisions for losses with
respect to bad debts and inventories
 gains and losses from fluctuations in
foreign exchange rates
 adjustments with respect to contract prices
 gains and losses from write-down or sale
of property, plant, equipment, or other investments
 income tax reductions on utilization of prior period
losses or reversal of previously recorded tax
benefits
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Unusual Items
The CICA Handbook recommends that companies
report separately “revenues, expenses, gains or
losses resulting from items that do not have all the
characteristics of extraordinary items but result from
transactions or events that are not expected to occur
frequently over several years, or do not typify normal
business activities of the entity” [CICA 1520.03(1)]
Note: Such items should not be shown net of tax.
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Earnings Per Share
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Public companies are required to report earnings per
share
Earnings per share (EPS) is a summary figure that is
often quoted by analysts and investors as the primary
(and sometimes only) indication of a company’s
earnings record
Public companies are required to report earnings per
share for both (1) income before discontinued
operations and extraordinary items, and (2) net
income
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Earnings Per Share (cont.)
.
 Basic earnings per share: computed by dividing
reported income available to the holders of common
shares by the weighted average number of common
shares outstanding during the year
 Fully diluted earnings per share: shows how
earnings per share would change in the event that all
common shares promised under the terms of existing
option agreements, conversion privileges on bonds or
preferred shares, etc., were actually issued
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Retained Earnings Statement
 The purpose of the retained earnings
statement is:
 to report all changes in retained earnings during the
accounting period
 to reconcile the beginning and ending balances of
retained earnings
 to provide a connecting link between the income
statement and the balance sheet
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Retained Earnings Statement (cont.)
 The major components of a statement of retained
earnings are:
1. Net income or loss for the period
2. Dividends
3. Error corrections
4. Cumulative effect of retroactive changes in
accounting policy
5. Other changes, e.g., capital transactions,
appropriations, and restrictions
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Retained Earnings Statement (cont.)
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Error corrections
Retroactive effect of a change in accounting
policy
Capital transactions
Other charges
Appropriations of and restrictions on retained
earnings
Prior period adjustments
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Error Corrections
 Sometimes involves restating the financial

statements of prior years, and thus changing
prior income that is summarized in retained
earnings
Proper disclosure of these changes is
accomplished by making an adjustment to
opening retained earnings for the cumulative
impact of the change to prior income, net of tax
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Error Corrections
 Opening retained earnings as restated are
presented
 Then, the comparative financial statements are
adjusted to give effect to the error correction
 A description of the error and its effect on the
financial statements must be included in the
disclosure notes
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Retroactive Effect of a Change in Accounting Policy
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The retroactive effect of a change in accounting
policy is also reflected on the retained earnings
statement
When an accounting policy is changed, the
comparability of the financial statements is
compromised unless all comparative numbers,
including prior years’ net incomes, are restated
using the newly adopted principle
This change in prior years’ income also changes
opening retained earnings as previously reported
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Capital Transactions
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Most capital transactions are share transactions
Gains and losses caused by these transactions are not
shown on the income statement because they are not
arm’s length transactions
Gains normally create contributed capitalseparate
shareholders’ equity accountsand losses reduce
retained earnings
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Other Charges

Other charges to retained earnings result from:
 share issue expenses incurred on the
issuance of new shares
 taxes resulting from a change in control or
triggered by dividend payments to
shareholders
 adjustments to retained earnings caused by a
reorganization
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Restrictions on Retained Earnings
 Restrictions result from legal requirements,
such as a statutory requirement that retained
earnings be restricted for dividend purposes
by the cost of any treasury stock held
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Appropriations of Retained Earnings
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Appropriations of retained earnings result from
formal decisions by the corporation to set aside, or
appropriate, a specific amount of retained earnings
(temporarily or permanently)
The effect of an appropriation is to remove the
specified amount of retained earnings from dividend
availability
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Prior Period Adjustments

In line with the all-inclusive concept of income, the
AcSB decided that prior period adjustments were, in
fact, related to normal operations and should be
recorded on the face of the income statement
Note: The category no longer exists
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